Why Money Management Firms Aren’t Trying to Make You a Lot of Money

Before you can figure out how to outperform Wall Street, you have to understand how the industry actually works.

The primary goal of the money management business has little to do with producing superior returns for you. The goal is to gather assets. Firms want control of your money, and they get it with the promise of keeping it safe and earning a good return.

The more assets a firm gathers and the longer it keeps them, the more it earns, and it collects that fee whether your account does well or badly. So the product is not returns. The product is assets under management.

Once your money is in the door, the priority shifts from growing it to keeping it. You do not keep a client by making him rich. You keep him by not losing him. A client down substantially starts looking for a new adviser. A client who trails the market by a point or two shrugs and lets his money sit for a decade.

So the rational strategy for investment advisers is to avoid the big loss rather than chase the big gain. Stay close to the benchmark and deliver returns good enough to justify the fee and safe enough that nobody runs away. Mediocrity is not a flaw in the model. It is the heart of the model.

Losing What Everyone Else Lost Won’t Get Anyone Fired

John Maynard Keynes described this 90 years ago. He wrote that it is better for your reputation to fail conventionally rather than to succeed unconventionally. The adviser who does the unconventional thing looks reckless and undisciplined to tradition-bound committees and boards. If they are successful, it only confirms the suspicion that they are taking too much risk. If they fail, they should have known better and are treated with contempt.

Keynes experienced exactly this while managing the endowment at King’s College, Cambridge. He ran a concentrated portfolio, lagged badly at times, and took heavy criticism. He was down 23% in 1938 when the market fell less than 9%, but over the full period he trounced the index.

This attitude and thinking are why Wall Street gravitated toward a method that guarantees nobody strays far from the average. Modern Portfolio Theory, implemented through asset allocation, does exactly what it was designed to do. It spreads your money across assets that do not move together, so the portfolio is less volatile than any single asset in it.

It also hugs the benchmark by construction. That cuts both ways. It protects you from disaster, but it guarantees you will never do much better than the index. You cannot allocate your way to returns meaningfully above the market, because the method and the business behind it are engineered specifically not to stray very far from it.

The Rules Come From Their Constraints

Diversify broadly. Stay fully invested. Do not concentrate. Every one of those is sound risk management for an institution running other people’s money. They have been handed to individual investors as if they are the bible of investing. They are not. They are the operating manual for producing the market’s return.

Here is what almost nobody thinks about. You cannot beat the status quo by trading according to the rules of the status quo. Allocate the way the industry allocates and stay invested the way it stays invested, and you will get the industry’s result. That is not a failure of execution. It is simple math.

What you possess, that the institutional whales of Wall Street do not, is freedom. A fund managing $50 billion cannot meaningfully own a company worth $300 million. Buying a position that size would drive the price up going in and collapse it going out. A fund that holds half cash is charging fees on money sitting still and clients will ask what they are paying for, so managers stay invested through conditions where the intelligent move is to own nothing. An institution is measured quarterly, so a thesis that needs two years has to survive eight performance reviews.

You have none of those constraints. That is the edge. Not superior insight, but the ability to act aggressively and instantaneously on the insight you have.

Where Aggressive Tactics Fit In

I want to be clear about what I am describing, because it is easy to read what I write as a case for trading your whole account aggressively. It is not. At my registered investment advisory firm, Hammerhead Financial Strategies, we limit the assets allocated to an aggressive strategy based on each client’s circumstances. What is different is that we make those aggressive tactics an important part of the allocation.

I don’t write much about lower-risk strategies. That is boring, and I can’t add much of value to that discussion. What I write about is high risk and high volatility. It produces big swings in both directions and can meaningfully beat the indices.

You cannot withstand those big volatile swings if your life savings is riding on them. Fear will force you to sell at the worst possible moment, and a single bad stretch will do permanent damage. The aggressive strategy works only when it is carved out of your wealth. There should be a slice you have deliberately set aside to take risk with, while the bulk of your money sits somewhere calmer and safer.

The stability of the rest is what makes the aggression possible. When most of your wealth is safe, you can sit through a brutal drawdown in the aggressive portion without panic, because it is a fraction of the whole and you always knew it would be violent. That tolerance is the whole edge. It is what lets you hold through the volatility that shakes everyone else out.

How Much Belongs in It

The size of that high-risk slice is not a random decision. It is determined by facts about your situation that no amount of conviction will change.

Two questions matter. How much time do you have, and how much can you lose without it altering your life? A thirty-five-year-old earning well, with decades of contributions ahead and no need to touch the money, can absorb a bad stretch in a way a seventy-year-old drawing income cannot. Not because of temperament, but because of arithmetic. The younger investor’s future savings can replace a loss. The retiree’s cannot, and a drawdown at the wrong moment does permanent damage because he is selling into it to pay his bills.

The same approach can be right for one person at twenty percent or more of the portfolio and wrong for another at any size. A retiree with a modest account has almost no room for it, and the honest advice is to keep the aggressive portion small or skip it entirely. Someone with substantial assets outside the account, a long horizon, and no need to draw on it has room to be aggressive with a meaningful slice.

The mistake I see most often is people getting this backward. They take too much risk when they can least afford it, usually because they are behind and hoping to catch up, and too little when they could easily afford more. The investor who needs the money soon is the one who should take the least risk with it, and he is frequently the one who takes the most.

Get the sizing right first. That is the conventional work we do as financial planners, and it has to come before anything else. You cannot decide how to run an aggressive portion until you know how large it should be, and you cannot know that without an honest accounting of your time horizon, your income, your other assets, and what a bad year would do to your life.

That is not exciting work. It is also what determines whether the aggressive slice is an opportunity or a disaster waiting for the wrong moment.

Most everything I write about on theStreetPro is meant for that aggressive slice and nothing more. The goal is not to beat the index with your whole portfolio, which is a fight you do not need to have. The goal is to take the portion you can afford to be aggressive with and make it do something the traditional allocation model never can.

That is a harder game and a more uncomfortable one, and that is exactly why it can help you escape Wall Street’s bias toward mediocracy.

At the time of publication, Guilfoyle had no position in any security mentioned.